Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Second Quarter 2017 Earnings Conference Call. Today's call is being recorded. [Operator Instructions]. It is now my pleasure to turn the floor over to Maria Cozine, Vice President of Investor Relations. You may begin.

Thanks, Victoria, and good morning. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature. As described under Item 1A of our annual report on Form 10-K filed on March 16, 2017, forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from it beliefs, expectations, estimates and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call, and the company undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. I have on the call with me today Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer. As described in our earnings press release, our second quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Management's prepared remarks will attract the presentation. Please turn to Slide 3 to follow along. With that, I will now turn the call over to Larry.

Thanks, Maria, and welcome, everyone, to our second quarter 2017 earnings call. We appreciate your taking the time to listen to our call today. In the second quarter, credit spreads continued to growing tighter and volatility remained historically low. Solid carry from our credit investments drove Ellington Financial's performance, with losses on our credit hedges and credit-relative value strategies partially offsetting that income. Our economic return for the quarter was a positive 85 basis points or 3.4% annualized. And our year-to-date economic return stood at 6.9% annualized through midyear. To give you a sense of how low volatility was on a historical basis, the 10-year treasury traded inside of 29 basis point range for the quarter, which we'd only see once before in the past 4 years. Also, the VIX hit a 23-year low and the MOVE, Merrill Lynch's option Volatility Index gets to a 4-year low. The yield curve continued to flat by 22 basis points, which was double the flattening of the first quarter. Despite the low volatility, we continue to find attractive opportunities to deploy capital and rotate our portfolio. We took advantage of tight non-Agency RMBS spread by selling a number of our U.S. non-Agency position and redeploying those proceeds into attractive U.K. nonconforming RMBS that we believe currently offer superior value to their U.S. counterparts. We also increased our investments in several high-yielding strategy, including our CLO, small-balance commercial mortgage and non-QM portfolios. Amidst the low volatility, we modestly increased the size of our credit portfolio from $640 million to $685 million, a level where we still see ample room to add assets prudently, particularly with some of the term, nonterm market, nonmark-to-market financing options available in the market today. In June, we marked a milestone by participating in Ellington's first self-managed CLO. We contributed…

Thank you, Larry, and good morning, everyone. On our Earnings Attribution table on Slide 18, you can see that in the second quarter, our credit strategy generated growth in terms of $9.4 million or $0.28 per share, and our agency strategy generated growth P&L of $370,000 or $0.01 per share. After expenses and other items, we had net income of $5.1 million or $0.16 per share. Last quarter, you can see that we had net income of $15.3 million or $0.47 per share. The following is a brief overview of the drivers of our credit and agency results. In our credit strategy, you can see that during the quarter, we had a $0.27 per share quarter-over-quarter decline in growth income. The most significant factors that drove this decline were our credit hedges and net results from our credit relative value-trading strategy. Credit hedges cost us around $0.11 a share, and our corporate credit relative values-trading strategy lost around $0.07 per share. Credit spreads on CMBS and high-yield corporates tightened during the quarter. And since we generally use short positions in these instruments in many of our credit strategies, the hedge credit risks, they generated net losses during the period. However, our long assets performed well during the quarter. We net sold U.S. non-Agency RMBS, CMBS and nonperforming and reperforming residential loans at meaningful gains. Our European assets benefited from tightening credit spreads and appreciated in value. While we had continued solid performance in our small-balance commercial mortgage loans, we did not have any significant resolution in the quarter. The timing of resolution tends to make P&L lumpy for this asset class. We increased the size of our long credit holdings by 7% or $45 million to $685 million. The net growth in our credit portfolio was in European RMBS, U.S.…

Thanks, Lisa. This quarter felt some ways like a continuation of last quarter. Interest rate volatility was low and generally favorable economic data led to a continued tightening in the structure credit spread. So against this backdrop, our bottom line results are a disappointment. While we made good progress in many areas, as Lisa mentioned, credit hedges dampened our results by $0.11. We had a $0.07 loss in our corporate credit relative value strategy. One big positive development was the CLO we did that Larry discussed. This is a great example of EFC using securitization market to manufacture its own high-yielding investment. As credit spreads have tightened, our ability to term finance -- term some of our portfolio of high-yielding assets via securitizations is vastly improved, and it's something we will look to do more of. Additionally, despite broadly tighter spreads in credit market, we were still able to grow our portfolio without sacrificing yields, adding another $45 million in credit assets, as shown on Slide 22. At the same time, parts of the asset pie shifted. As we contributed bank loans to our CLO securitization, the corporate debt pie shrunk and the CLO size grew. European assets grew as we saw spreads there lagging the tightening in the U.S. spread. Our residential NPL portfolio also grew a little. Not only have securitization economics improved, but nonsecuritization financing, especially, term banks facility financing have also improved recently and it has improved in 2 dimensions. Firstly, spreads to LIBOR are lower and equally important the tender of financing terms have increased. In the consumer loan sector, we continued aggregating loans into 3 existing flow arrangements. We closed our term credit facility for our largest consumer loan flow agreement in the first quarter of this year. And we expect in the third…

Thanks, Mark. In the second quarter, we continue to see a steady pipeline of high-yielding loans and securities. Our assets continue to perform well. And our outlook for their future performance is extremely positive. As Mark and Lisa mentioned, we were able to grow our credit portfolio by 7%, which isn't the level of growth we'd ideally like to see. However, that 7% figure really doesn't tell the whole story, since we securitized enough. For example, on our CLO transaction, we contributed leveraged loans and took back CLO tranches. And as you'd expect on a net basis, our overall portfolio decreased having freed up capital for future asset acquisitions. As we continue to securitize portions of our portfolio of yield-bearing asset, the overall size of our credit portfolio has got to experience more of this 2 steps forward, 1 step back phenomena. But ultimately, we'll end up with a much more robust earning stream. We think that it's especially important in this market environment to be disciplined as we add asset. We have built our pipelines and sourcing capabilities for a reason. We believe that they provide us with much better risk-adjusted returns and can be found in the commoditized markets. We don't want to sacrifice quality for speed. We now have so many different strategies that we can draw on. And I believe that it was a bit of an anomaly that our credit portfolio only grew by 7% this past quarter. As I said, it will be 2 steps forward and 1 step back, as we accumulate assets and then do securitizations, but we will get there. I did want to mention one other notable development this past quarter relating to our robust mortgage origination joint venture Longbridge Financial. Longbridge has continued to expand its footprint. And in…

[Operator Instructions]. Your first question comes from the line of Steve Delaney with JMP Securities.

A message came through loud and clear here on the call listening to your comments that your future focus at least in the -- if this market environment prevails is going to continue to exit QSubs and focus heavily on whole loans of various types. I'm just curious and not only if it's possible for you to do, but is -- you've mentioned maybe as many as 5 different loan types. Can you sort of order in some way where you think the greatest opportunities, maybe the top 2 opportunities within the whole loan universe that you're currently targeting?

Yes, it's -- Steve. It's really -- it's -- so some of it's hard to predict, right. I think our best performance strategy over years now has been our small-balance commercial mortgage strategy, which is both stressed and bridge loans. And we are certainly hopeful that flow will increase there. And where -- I think it would be great. It's very hard to predict kind of the pace of that. But it's certainly, one of the asset classes that we would like to see grow more. And our strategy where we've had, again, a pretty small deployment of capital is the residential NPL/RPL strategy. And we just want to have all these different strategies so that when something really attractive comes to market, we can add it any one of these sectors. Non-QM, that's more visible right in terms of the pipeline that we have from our partner. And that was a little more predictive in terms of their ramping up their origination volume, but so we can be a little more predictive there. I think if the mark would have crack right, and all bets are off. And as you can see, we're still somewhat defensive on the security side. Credit risk transfer is something that Mark mentioned is the factor that we think is very tight. But if the GSEs change their policies there and start to issue more that paper or something else happens in the overall markets, we think that could be a market that has shown to move very quickly in the past and that could be a great entry point there. So I don't want to sit here and say that we're necessarily a year from now or 6 months from now going to have no QSubs in our portfolio. But you're right that many of the opportunities we're seeing are in these less commoditized loan sectors as opposed to the QSub sectors. On CLOs, though, I have to say right. Those are QSubs. And that's been a profitable strategy for us. I think we said we moved away from legacy. Maybe I'm being a little hypertechnical here, but now the focus for us has been more in some of the post-legacy, but still seasoned sectors like 2012, 2013, which we're seeing good opportunities there and a lot of deleverage deal. So and QSubs in Europe is another good example, right. We added our -- to our U.K. RMBS. And Mark you want to add?

Yes. Steve, I want to add one thing that the fact that the securitization markets are open and execution is tight, that's sort of transformational for liquidity on many types of loans, but non-QM loans because you can securitize them now and there has been consistent deal flow and there's sort of a defined market, that mix that sector are a lot more liquid. And I think the same thing is the bank loans where you connect advertising through a CLO. So that's a big change in the market from 3 years ago, especially, on the non-QM side that loans become a lot more liquid if there is a relatively healthy robust consistent securitization market, so it's down in liquidity...

I think this is an interesting development, I think, for the mortgage REITs broadly. And it seems like we have -- well, I'm going to come back to the agency strategy. Let me just finish with this. It has been ever since we heard of what a hybrid REIT was, I think it was 0.8, 0.9. It was obviously a postcrisis kind of development to take advantage of legacy RMBS. But it seems like over the last year or 2, what Trevor and I scratch our heads about is it seems the legacy trade is so played out, where are we going to create new credit. Redwood was trying to do it in the jumbo space. And you guys have been pioneers in -- through your joint ventures, but it seems to us that, that somehow another if you're going to be a credit mortgage REIT, you are going to need to tap into the -- create your own flow of collateral. It just -- and it seems to me that's where you're going. And it's evolving, I think, you guys are aware of this. We now have a public small-balance commercial mortgage REIT. And we now have a public NPL/RPL. So I think as you grow these strategies, I think investors will -- you'll start running into investors that actually understand that business model because a couple pure play names that are educating the space will involve...

Yes, I think that's a great point. And we absolutely agree that especially in the small-balance commercial areas that's a very small fruitful area. We want to though be able to have diverse portfolios that were ever -- we see the opportunity. We want a foothold, certainly, in each place, but we want to be able to go where we think the best attractive returns are. And one advantage of our not being a REIT is we can also play in the consumer space as well. And so...

Right. Your consumer relationships are sort of on a flow basis, right?

That's right.

And I assume your NPL/RPLs, you're looking at pools, right, that are...

We're not. So we're not. Exactly, that's not something where we're creating our own flow per se. We're operating a little bit below the radar screen in terms of the size of the pools that we're buying. But that's been a -- the nice thing about that market is that it's again a very predictable market by things, which we like to do, of course, at a very low implied loan-to-value ratio in terms of the underlying asset that's securing the loan. So where we feel like that strategy is very steady, doesn't have a lot of downside and now that we've had -- and we haven't really had lines -- really, really good lines in that space for more than a year, I don't think so. That's definitely a possible area for growth given that the type of lines that we have, financing lines we're referring to are now a lot more attractive, not just in terms of rates, but also, in terms than they were several years ago.

And Larry, do you -- on your small-balance commercial, do you have anything like a flow arrangement there? I'm not asking for names by any means. Just is that a business you can do on flow? Or do you have to do sort of many balls there as well?

No, no, no. Not many balls. It's relationship. It's brokers and relationships. So in that sense, we definitely feel like we are in some manner, in control of our own sourcing. On the bridge loan side, we do have specific relationships. We're not exclusive, but we have specific relationships that we take advantage of there. And we also have some common asset servicers that we deal with and not only service the asset to help us resolve them, but also, have -- they are tentacles out into the market and help us source a lot of assets as well.

Your next question comes from the line of Eric Hagen with KBW.

You guys have, historically, been pretty active in trading sovereign credit. And it looks like the core short position in European sovereign bonds is pretty stable in the second quarter. How do you think about that position given both the level of rates in Europe as well as the potential withdrawal of stimulus from the European Central Bank?

Yes. So just to be clear. That position is and always has been a hedge, mostly a currency hedge and to a lesser extent, a credit hedge, but a little of both in the -- just for our European assets. So we've talked about Spanish NPLs in the past for example. We had French assets. So U.K. assets obviously. So we want to hedge our currency risk obviously, and that's like interest rate risk. That's the thing that we would hedge religiously I would say. But in terms of credit risk, we think that these have the additional benefit being short to sovereign, not only of hedging currency, but also having a correlation to be sure with whatever underlying asset we have in that country. So that explains those. So we're not -- it's not sort of a global credit hedge, the way that we might have it in other market. The way you might see be in active things like that. It's a very, very specific hedge against an asset that we have in a particular country.

Your next question comes from the line of Jessica Levi-Ribner with FBR Capital Markets.

Most of have been asked and answered, but a quick one on the NPL/RPL market. If you could talk a little bit about the trends you're seeing there, and how you're thinking about investment going forward? I know the market is pretty well bid and so I'd love to hear your thoughts?

Sure. This is Mark. So the way we think about sourcing is that we have found that the [indiscernible] or packages from the big bank and from HUD are priced much lower expected returns than smaller- or medium-sized packages that we might source from banks. So we focused a lot on sourcing packages from sellers that are smaller and also, sellers that did not have the capability to thoughtfully and aggressively service the loans over time. So I think one nice thing about that strategy is in that strategy we generate returns in part to hard work, not necessarily from market movement. So we have found it. The team we have in place there has done a really great job in creating value in our loan by working with borrowers, by cleaning up loan file, by getting trailing doc. So the combination of sourcing loans from sellers that aren't as competitive and also, sourcing loans from sellers that haven't necessarily got all the resolutions they could get out of a package has what driven our returns. And then when we go to exit, we've seen a very healthy market for reperforming loan from some of the platforms that aggressively look to add assets there. So we've been able to, I think, source yield tiered into average market yield. We've done a good job in getting better resolutions and getting better performance out of the loans from the efforts of the team. And then, when we go to exit, we're finding a fairly liquid market to exit loans when they've hit their targeted return strategy. So we like that sector very much. We're going to keep sort of that approach to it.

And just, I want to add one more thing which is that when those packages are put out for bid as opposed to some of the bigger packages, right, you're going to have -- a lot of times you're going to be able to get exclusive. It's not going to be -- people know they can't. There's a lot of work that comes into bidding one of these packages. So for small package it's not kind of thing where you're going to able to get 20 people to do all the work and getting comped away you can for Fannie Mae package. So we can sort of take advantage of that, pick our spot and get more of an exclusive relationship with seller through a broker usually for those packages that do trade cheaper because they're smaller.

Our next question comes from the line of George Bahamondes with Deutsche Bank.

Just had a question on what you guys are seeing in the third quarter. I understand that there was a bit of headwinds in the second quarter with regard to credit spread tightening and your hedges kind of bringing down your earnings for the quarter. Again, just really trying to wrap my head around what we should expect for the second half of '17 thinking the way that I was modeling this year. Again, I expected thing to turn around and I know that the tightening of credit spread that has an impact given your exposure to that. You've reduce ted exposure quite a bit versus '16, but -- how should we think about the second half of '17 given that some of the strategies you guys are focused on aren't wrapping up quite as quickly as you'd expect them to?

Yes. So thanks for the question. First of all, I do want to say that usually around that business there at month -- which will be Monday, that's normally, we don't preannounce these things. But normally, on Monday would be when we would publish our estimated book value for July. So I'd rather not talk about July, overall, at this point, but you'll see something just probably early next week. In terms of looking forward to the second half of the year, I would like to point out that we did cover our dividend in the first quarter. In the second quarter, if you strip out those effects that leads to quantify $0.11 or so and the credit hedges $0.07 or so on that rallied by trading strategy that we did just disclose was profitable in July. Then, you're pretty close to the dividend, right. So if you add that back to our earnings quarter-to-quarter. So I think we're, as I said, I don't think we're quite there in terms of where we want to be, in terms of having that portfolio of yield-bearing assets, the size, the way we wanted to be sized. We still have extra capital. You can see that in our cash balance. And you can see that in the sizing of some of the strategies like Guerilla value strategy that are still being used while we're ramping up. But yes, so I think for the next quarter or so and if you look on Slide 7 -- thanks Lisa, you can see that we have capital that we view as utterly undeployed of 11%. And that's not an unusual number for us, but I'd like to point out that included in the other capital numbers is risk capital as well. That extra capital we set aside to counter the fact that if we got repos you might have margin calls, repo role risk. A lot of it's related to the repo. So -- which I think is going to also tough also from our call, we're moving away from repo, right. Moving more towards things like term banks financing, for example, in the consumer portfolio and securitization plan, I think, ultimately on some other thing. So yes, so I think that's how I would think of it. What's the expression, trees don't grow to the sky. So I think that the drag from these credit hedges is got to be largely played out. I'm never going to say it's totally played out, but we think that it's still a very prudent hedge to have in place even where spreads are, especially, in so many of these commoditized sectors. So I -- we're not -- in our DNA, we're not going to just toss those out because they have performed well.

Right. Okay. That's helpful. Just -- I do appreciative the comments just given I know the credit hedges were a bit of a headwind in '16. So seeing that again this quarter was a bit of a surprise to me.

Thank you. That concludes today's conference call. Thank you for your participation. You may now disconnect.